Inflationary Head Fake

Today (Friday the 5th) has a meaningful feel. The news is good on U.S. employment
and Greek finances, and the markets are in recovery mode: stocks are up, gold
is rocking, and bonds are getting smacked. Inflationary days are here again,
in other words. But -- while uncontrolled currency creation will absolutely
without a doubt get us there eventually -- today's action is probably a head
fake. Consider:

The rising gas tax.Oil
hit $82 today, which, while a long way from its credit bubble high,
is still enough to take U.S. gasoline to nearly $3 a gallon in some markets.
That's effectively a tax increase on U.S. drivers.

Public sector bloodbath. Job losses diminished last month, which is
leading some to predict that unemployment has topped out. But today's numbers
don't account for the massive cutbacks in state and local governments that
are now in the pipeline. Mike Shedlock over at Mish's Global Economic Trend
Analysis has been covering the
public sector story. And check out this
speech by New Jersey's promising governor Chris Christie, in which
he lays it out in painful detail.

The short version of the story is that over the past couple of decades governors
and mayors in badly-run states like California, New Jersey, New York and Illinois
allowed public sector salaries and pensions run out of control, and now they're
broke. They'll spend the coming year laying off workers and cutting pay and
benefits, which will cause public employees to spend a lot less, which will
produce more layoffs in private sector industries whose stuff the public sector
workers would have bought.

More bad international news. Greece, to its credit, is braving some
major protests to make legitimate cuts in public sector wages and
benefits. Impressive under the circumstances. But the result will be slower
growth and lower tax revenues going forward, so it's not clear that it's
even possible to use austerity without devaluation to fix this kind of
imbalance. And Greece, as pretty much everyone knows by now, is just the
tip of the iceberg. The bigger PIIGS countries, along with Great Britain,
are still to come, and their travails will be front page news for the rest
of the year.

Spiking interest rates. While U.S. long-term Treasury bond yields were
settling in at historic lows, two memes were spreading: 1) fiscal imbalances
will force governments around the world to inflate, making bonds a bad bet,
and 2) a recovery, when it comes, will enable monetary authorities to withdraw
some excess liquidity and allow interest rates to rise to more normal levels.
Whichever of these seems most reasonable, the resulting impulse is the same:
to look for a sell/short point for Treasuries. Today, when the news is only
mildly bullish (employment still went down, after all) bonds are being sold
off hard.

So interest rates are poised to jump as soon as the world stops worrying about
deflation. The move will likely be hard and fast, taking mortgage rates along
for the ride. With the U.S. housing market barely hanging on despite huge subsidies
for new home buyers, mortgage rates back in the 6.5% range will stop the housing
recovery in its tracks -- and push real estate-dependent states like California
and New York further over the edge.

Add it all up and you get a system that's vulnerable to bad news, with a lot
of bad news coming. If any of the above -- a spike in oil or interest rates,
massive layoffs in California/New York/Illinois, a budget crisis in Britain
or Spain -- end up happening, then today will seem like one of those dreams
from which you're sorry to wake up.

John Rubino edits DollarCollapse.com and has authored or co-authored five
books, including The Money Bubble: What To Do Before It Pops, Clean
Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar
and How to Profit From It, and How to Profit from the Coming Real Estate
Bust. After earning a Finance MBA from New York University, he spent the
1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst.
During the 1990s he was a featured columnist with TheStreet.com and a frequent
contributor to Individual Investor, Online Investor, and Consumers Digest,
among many other publications. He now writes for CFA Magazine.